Monday, April 19, 2010

With a lot of money sloshing around the P&C and reinsurance businesses the carriers are not getting paid to take on risk. At the same time it looks as if 2010 is setting up to be a busy hurricane year.A couple posts at Wunderblog caught my eye last week:

...El Niño fades from moderate to weakEl Niño slowly weakened during late March and early April, and El Niño conditions crossed the threshold from moderate to weak during the past two weeks. Sea surface temperatures over the tropical Eastern Pacific in the area 5°N - 5°S, 120°W - 170°W, also called the "Niña 3.4 region", were at 0.83°C above average on April 11, which is just below the 1.0°C threshold to be considered a moderate El Niño, according to the Australian Bureau of Meteorology. Anomalously strong westerly winds along the Equator that had helped maintain the current El Niño slackened in late March, and winds are now near average over the Equatorial Pacific. It now appears very likely that El Niño will be gone by hurricane season. None of the sixteen El Niño models (updated as of April 15) are predicting El Niño will be around during the height of hurricane season (August-September-October); six are predicting La Niña conditions for hurricane season. The expected demise of El Niño, coupled with sea surface temperatures in the tropical Atlantic that are currently at record levels, have prompted two major hurricane forecasting groups (tropicalstormrisk.com and Colorado State University) to predict a well-above average 2010 Atlantic hurricane season....

So El Nino can't be counted on for wind shear this year. The bigger story might be:

Record Atlantic SSTs continue; very active hurricane season foreseen by CSU and TSR

Sea Surface Temperatures (SSTs) in the Atlantic's Main Development Region for hurricanes had their warmest March on record, according to an analysis of historical SST data from the UK Hadley Center. SST data goes back to 1850, though there is much missing data before 1910 and during WWI and WWII. The region between 10°N and 20°N, between the coast of Africa and Central America (20°W - 80°W), is called the Main Development Region (MDR) because virtually all African waves originate in this region. These African waves account for 85% of all Atlantic major hurricanes and 60% of all named storms. When SSTs in the MDR are much above average during hurricane season, a very active season typically results (if there is no El Niño event present.) SSTs in the Main Development Region (10°N to 20°N and 20°W to 85°W) were an eye-opening 1.26°C above average during March. This easily beats the previous record of 1.06°C set in 1969. SSTs in the Main Development Region are already warmer than they were during late June of last year, which is pretty remarkable, considering that March is one of the coldest months of the year for SSTs in the North Atlantic. Last month's anomaly of 1.26°C tied with June 2005 as the greatest monthly anomaly ever recorded in the Atlantic MDR.

Figure 1. The departure of sea surface temperature (SST) from average for April 12, 2010. Image credit: NOAA/NESDIS.

What is responsible for the high SSTs?As I explained in detail in last month's post on record February SSTs in the Atlantic, the Arctic Oscillation (AO) and its close cousin, the North Atlantic Oscillation (NAO), are largely to blame for the record SSTs. The AO and NAO are climate patterns in the North Atlantic Ocean related to fluctuations in the difference of sea-level pressure between the Icelandic Low and the Azores-Bermuda High. If the difference in sea-level pressure between Iceland and the Azores is small (negative NAO), this creates a weak Azores-Bermuda High, which reduces the trade winds circulating around the High. During December - February, we had the most negative AO/NAO since records began in 1950, and this caused trade winds between Africa and the Lesser Antilles Islands in the hurricane Main Development Region to slow to 1 - 2 m/s (2.2 - 4.5 mph) below average. Slower trade winds mean less mixing of the surface waters with cooler waters down deep, plus less evaporational cooling of the surface water. As a result, the ocean heated up significantly, relative to normal, over the winter. This heating is superimposed on the very warm global SSTs we've been seeing over the past few decades due to global warming. Global and Northern Hemisphere SSTs were the 2nd warmest on record this past December, January, and February. We are also in the warm phase of a decades-long natural oscillation in Atlantic ocean temperatures called the Atlantic Multi-decadal Oscillation (AMO). This warm phase began in 1995, and has been partially responsible for the high levels of hurricane activity we've seen since 1995.

What does this imply for the coming hurricane season?The high March SST anomaly does not bode well for the coming hurricane season. The three past seasons with record warm March SST anomalies all had abnormally high numbers of intense hurricanes. Past hurricane seasons that had high March SST anomalies include 1969 (1.06°C anomaly), 2005 (0.93°C anomaly), and 1958 (0.93°C anomaly). These three years had 5, 7, and 5 intense hurricanes, respectively. Just two intense hurricanes occur in an average year. The total averaged activity for the three seasons was 15 named storms, 11 hurricanes, and 6 intense hurricanes (an average hurricane season has 10, 6, and 2.) Both 1958 and 2005 saw neutral El Niño conditions, while 1969 had a weak El Niño. So, even if this year's El Niño lingers on into hurricane season, it may not protect us from a hyper-active hurricane season--the weak El Niño year of 1969 had 18 named storms, 12 hurricanes, and 5 intense hurricanes....MUCH MORE

I don't have time to go into a lot of detail right now, maybe next week. The current overcapacity in P&C, which has led to a bit of a price war, will be ending soon, maybe three to six weeks.A back of the envelope calculation says insurers would be mis-pricing weather risk vs. "average" conditions.

The recent flip of the Pacific Decadal Oscillation to it's cold phase will, if past history repeats, lead to higher insured losses in everything from hail damage to landfalling hurricanes....

The price war we were referencing has lasted longer than we expected three months ago. Research Recap had some commentary on insurance pricing last week:

US Home Insurers Set to Report Underwriting Loss This Year

The US homeowners insurance industry will report a modest underwriting loss in 2008 as rates fall due to excess capacity, an abundance of reinsurance options as well as regulatory and political pressures, Fitch Ratings says. In a new report on the industry, Fitch notes that although insurers have experienced improved underwriting results over the past six years, market fundamentals have deteriorated recently.

The industry failed to produce an underwriting profit for 15 years prior to 2003. Fitch believes that poor underwriting results in the homeowners business originated from the line serving more as a “loss leader” to attract automobile insurance business for many insurers. Other explanations for underperformance include artificially low prices to increase market share and a lack of sophistication regarding catastrophe management....MORE

We'll come back to this over the next few months. For now, use the "Search Blog" box, keyword Pacific Decadal Oscillation or PDO.

Even better than having subsequent reports practically parrot your prediction's phrasing is the fact that getting on the right side of the trade made it easier to position for the disaster that followed (e.g. AIG down 97%, HIG down 80%).

The contrarian bet idea came out of the recent Colorado State and WSI forecasts for an active hurricane season in 2009 combined with the uncritical attention paid to Munich Re's world catastrophe report on Monday (to my jaundiced eye it seemed written to maximize property/casualty premiums).Although there are big gaps in our knowledge base and plenty of room for disagreement among the tropical cyclone cognesceti, there is a correlation between the Atlantic Multidecadal Oscillation and Atlantic basin hurricanes. According to the National Oceanic and Atmospheric Administration:

...How important is the AMO when it comes to hurricanes - in other words - is it one of the biggest drivers? Or Just a minor player?

During warm phases of the AMO, the numbers of tropical storms that mature into severe hurricanes is much greater than during cool phases, at least twice as many. Since the AMO switched to its warm phase around 1995, severe hurricanes have become much more frequent and this has led to a crisis in the insurance industry.

Does the AMO influence the intensity or the frequency of hurricanes (which)?

The frequency of weak-category storms - tropical storms and weak hurricanes - is not much affected by the AMO. However, the number of weak storms that mature into major hurricanes is noticeably increased. Thus, the intensity is affected, but, clearly, the frequency of major hurricanes is also affected. In that sense, it is difficult to discriminate between frequency and intensity and the distinction becomes somewhat meaningless....

The AMO tends to stay in predominantly the cool or warm phase for extended periods but the temperature anomaly does does change from month to month: